United Airlines' Bull Case Deteriorates, Leading To A Credit Suisse Downgrade

Given the expectations for fuel prices and assumptions regarding labor deals, Credit Suisse’s Julie Yates believes United Continental Holdings Inc UAL is likely to see a more muted unit revenue recovery.

Yates downgraded the rating on the company from Outperform to Neutral, while lowering the price target from $64 to $42.

The analyst mentioned, “It's prudent to fully load numbers for higher labor as it is a question of when not if wage rates will move materially higher.”

Bulls Investors Grow Impatient

Yates believes earlier in 2016, bullish investors had focused on the impressive free-cash-flow yield and generous buybacks as reasons to hold on to the stock, while the new leadership team focused on the margin convergence story.

However, with capex accelerating, the analyst believes the free-cash-flow story has been impacted, slowing delivering and marking 2016 as the peak for shareholder returns.

Related Link: American Airlines Cut At Credit Suisse, Calls January Upgrade Too Optimistic

According to the Credit Suisse report, “CEO Munoz laid out earnings initiatives already underway June 21 and is widely expected to bolster his C-Suite bench in coming months, further defining a path forward to narrow the margin gap to peers by year-end.”

Yates expressed concerns regarding investors becoming impatient with the pace of change, saying that skepticism about United Continental’s ability to deliver margin improvement would only grow.

Margin Convergence Challenges

“CEO Munoz has first focused on reengaging employees with generous pay increases all hitting 2016/2017 which will largely offset benefits from upgauging and productivity gains, pushing ex fuel unit cost growth above inflation for two consecutive years,” Yates pointed out.

The analyst believes against a backdrop of rising labor costs, the way to narrow the margin gap would be through unit revenue outperformance. However, this could prove difficult due to geographic exposures and competitive capacity growth.